Abstract

Citations (1)

Using the URL or DOI link below will
ensure access to this page indefinitely

Based on your IP address, your paper is being delivered by:

New York, USA

Processing request.

Illinois, USA

Processing request.

Brussels, Belgium

Processing request.

Seoul, Korea

Processing request.

California, USA

Processing request.

If you have any problems downloading this paper,please click on another Download Location above, or view our FAQFile name: SSRN-id2274756. ; Size: 570K

You will receive a perfect bound, 8.5 x 11 inch, black and white printed copy of this PDF document with a glossy color cover. Currently shipping to U.S. addresses only. Your order will ship within 3 business days. For more details, view our FAQ.

Quantity:Total Price = $9.99 plus shipping (U.S. Only)

If you have any problems with this purchase, please contact us for assistance by email: Support@SSRN.com or by phone: 877-SSRNHelp (877 777 6435) in the United States, or +1 585 442 8170 outside of the United States. We are open Monday through Friday between the hours of 8:30AM and 6:00PM, United States Eastern.

University of Delaware - John L. Weinberg Center for Corporate Governance

August 7, 2012

Abstract:

In setting the pay of their CEOs, boards invariably reference the pay of the executives at other enterprises in similar industries and of similar size and complexity. In what is described as “competitive benchmarking”, compensation levels are generally targeted to either the 50th, 75th, or 90th percentile. This process is alleged to provide an effective gauge of “market wages” which are necessary for executive retention. As we will describe, this conception of such a market was created purely by happenstance and based upon flawed assumptions, particularly the easy transferability of executive talent. Because of its uniform application across companies, the effects of structural flaws in its design significantly affect the level of executive compensation.

It has been observed in both the academic and professional communities that the practice of targeting the pay of executives to median or higher levels of the competitive benchmark will naturally create an upward bias and movement in total compensation amounts. Whether this escalation has been dramatic or merely incremental, the compounded effect has been to create a significant disparity between the pay of CEOs and what is appropriate to the companies they run. This is not surprising. By basing pay on primarily external comparisons, a separate regime which was untethered from the actual wage structures of the rest of the organization was established. Over time, these disconnected systems were bound to diverge.

The pay of a chief executive officer, however, has a profound effect on the incentive structure throughout the corporate hierarchy. Rising pay thus has costs far greater than the amount actually transferred to the CEOs themselves. To mitigate this, boards must set pay in a manner in which is more consistent with the internal corporate wage structures. An important step in that direction is to diminish the focus on external benchmarking.

We argue that: (I) theories of optimal market-based contracting are misguided in that they are predicated upon the chimerical notion of vigorous and competitive markets for transferable executive talent; (II) that even boards comprised of only the most faithful fiduciaries of shareholder interests will fail to reach an agreeable resolution to the compensation conundrum because of the unfounded reliance on the structurally malignant and unnecessary process of peer benchmarking; and, (III) that the solution lies in avoiding the mechanistic and arbitrary application of peer group data in arriving at executive compensation levels. Instead, independent and shareholder-conscious compensation committees must develop internally created standards of pay based on the individual nature of the organization concerned, its particular competitive environment and its internal dynamics.